Free carried interest

Implications for oil and gas sector

The uncertainly created by the 'free carried interest' provided for in the draft Mineral and Petroleum Resources Development Bill may discourage potential investors in South Africa’s oil and gas industry.

Lizel Oberholzer, director at Bowman Gilfillan, the leading pan-African corporate law firm with a team dedicated to the oil and gas sector, commented: “At present, the state’s interests in exploration and production rights are not legislated, but are provided for in the standard form exploration and production rights.

“In terms of these rights, the state may exercise an option to acquire a 10% participating interest in a production right through an organ of state. The state is not liable for past expenses, but contributes in proportion to its participating interest toward production costs.”

In terms of the new amendments, the state may acquire a 'free carried interest' in exploration and production rights. The percentage of participating interest is not clear, as the bill does not specify whether the free carried interest will remain at 10%, or increase.

“There is also no indication that the state will make any contribution to costs. Moreover, the state has an option to acquire a further interest on terms that it decides,” said Oberholzer.

The state’s interest, which is unspecified but is unlikely to be lower than the 10% interest that is currently reserved for the state, together with the increased black economic empowerment interest of 26.5%, reduces the percentage interest available to local and international oil companies, which may prejudice investment in the South African petroleum sector, she added.

“Ordinarily, a state will increase its percentage interest only once there has been a substantial and commercially viable discovery in its country. This reduces the risk to investors who are happy to part with a larger share of their profits for the security of highly prospective resources.

“However, South Africa is yet to make a substantial discovery, and therefore the amendments are premature and are likely to dampen interest shown by investors in South African oil and gas resources. This may have a negative knock-on effect on communities who would benefit from social and labour investments by international oil companies, as well as the fledgling service provider industry.”